True/False (1 point each). For each question, enter (a) for True and (b) for False.
1. An income statement reports the firms revenues and expenses for a specific period of time such as one year.
2. An example of a perpetuity is a bond with an interest rate that remains constant over the life of the bond (i.e., until the bond matures).
3. A return of 12% compounded annually is the same as a return of 1% per month.
4. If a bond sells for its par value, the coupon interest rate and yield to maturity are equal.
5. An inverted yield curve implies that the market expects interest rates to rise in the future.
6. Preferred stock is less risky than common stock, but more risky than debt.
7. A general partnership, unlike a limited partnership, is an entity that legally functions separate and apart from its owners.
8. Profit maximization is not the goal of the firm because accounting profits do not accurately measure the timing and uncertainty of a company’s cash flows.
9. The corporation is a legal entity separate from it owners; thus it is possible for the corporation to continue even upon the death of one or more shareholders.
10. If two companies have the same revenues and operating expenses, their net incomes will still be different if one company finances its assets with more debt and the other company with more equity.
11.
Multiple Choice (3 points each)
11. Company A and Company B both report the same level of sales and net income. Therefore, ________.
a. both A and B will report the same Earnings Per Share
b. both A and B will report the same Gross Profit Margin
c. both A and B will report the same Net Profit Margin
d. both A and C are true
12. Which of the following questions are addressed by financial managers?
I. How long will it take to produce a product?
II. How long should customers be given to pay for their credit purchases?
III. Should the firm borrow more money?
IV. Should the firm build a new factory?
a. I and IV only
b. II and III only
c. I, II, and III only
d. II, III, and IV only
e. I, II, III, and IV
13. Which one of the following statements is correct?
a. Both partnerships and corporations incur double taxation.
b. Both sole proprietorships and partnerships are taxed in a similar fashion.
c. Partnerships are the most complicated type of business to form.
d. All types of business formations have limited lives.
14. Which one of the following actions by a financial manager creates an agency problem?
a. refusing to borrow money when doing so will create losses for the firm
b. refusing to lower selling prices if doing so will reduce the net profits
c. expanding the company resulting in a decline in stockholders value
d. agreeing to pay bonuses based on the market value of the company stock
e. increasing current costs in order to increase the market value of the stockholders
equity
15. Which of the following is a disadvantage to organizing as a C Corporation?
a. Owners are subject to unlimited liability for the firms debts
b. Changes in ownership will not dissolve the firm
c. Earnings are subject to taxation at the corporate and personal level
d. Owners have no control over the actions of the manager
e. Corporations have easy access to capital
16. Li Retailing reported the following items for the current year: Sales = $2,000,000; Cost of Goods Sold = $1,200,000; Depreciation Expense = $140,000; Administrative Expenses = $170,000; Interest Expense = $40,000; Marketing Expenses = $60,000; and Taxes = $20,000. Lis gross profit is equal to ________.
a. $800,000
b. $490,000
c. $430,000
d. $410,000
17. The process of finding the present value of some future amount is often called:
a. growth.
b. discounting.
c. accumulation.
d. compounding.
e. reduction.
18. As the discount rate increases, the present value of $500 to be received six years from now:
a. remains constant.
b. also increases.
c. decreases.
d. becomes negative.
e. will vary but the direction of the change is unknown.
19. You hope to buy your dream house six years from now. Today your dream house costs
$189,900. You expect housing prices to rise by an average of 4.5 percent per year over
the next six years. How much will your dream house cost by the time you are ready to
buy it?
a. $240,284.08
b. $246,019.67
c. $246,396.67
d. $246,831.94
e. $247,299.20
20. Alpha, Inc. is saving money to build a new factory. Six years ago they set aside
$250,000 for this purpose. Today, that account is worth $306,958. What rate of interest
is Alpha earning on this money?
a. 3.36 percent
b. 3.42 percent
c. 3.48 percent
d. 3.55 percent
e. 3.60 percent
21.You are comparing two annuities which offer monthly payments for ten years. Both annuities are identical with the exception of the payment dates. Annuity A pays on the first of each month while annuity B pays on the last day of each month. Which one of the following statements is correct concerning these two annuities?
a. Both annuities are of equal value today.
b. Annuity B is an annuity due.
c. Annuity A has a higher present value than annuity B.
d. Annuity B has a higher present value than annuity A.
e. Both annuities have the same future value as of ten years from today.
22. You are the beneficiary of a life insurance policy. The insurance company informs you that you have two options for receiving the insurance proceeds. You can receive a lump sum of $50,000 today or receive payments of $641 a month for ten years. You can earn 6.5 percent on your money. Which option should you take and why?
a. You should accept the payments because they are worth $56,451.91 today.
b. You should accept the payments because they are worth $76,523.74 today.
c. You should accept the payments because they are worth $126,737.08 today.
d. You should accept the $50,000 because the payments are only worth $6,223.10 today.
e. You should accept the $50,000 because the payments are only worth $47,808.17 today.
23. The Great Giant Corp. has a management contract with their newly hired president. The contract requires a lump sum payment of $25 million be paid to the president upon the completion of her first ten years of service. The company wants to set aside an equal amount of funds each year to cover this anticipated cash outflow. The company can earn 6.5 percent on these funds. How much must the company set aside each year for this purpose?
a. $1,775,042.93
b. $1,798,346.17
c. $1,801,033.67
d. $1,852,617.25
e. $1,938,018.22
24. You recently filed suit against a company. Today, you received three settlement options as follows:
Option A: $10,000 on the first day of each year for 25 years
Option B: $880 on the first day of each month for 25 years
Option C: $119,830 as a lump sum payment today
You can earn 7.5 percent on your investments. You do not care if you personally receive the funds or if they are paid to your heirs should you die within the next 25 years. Which one of the following statements is correct given this information?
a. Option C is clearly the best choice since you can earn 7.5 percent on the entire lump sum starting immediately.
b. Option B is clearly the best choice since it offers the largest number of payments.
c. Option A is clearly the best choice since it has by far the largest future value.
d. Option B is clearly the best choice since it has by far the largest present value.
e. You are relatively indifferent to the three options as they are all approximately equal in value to you.
25. Marko, Inc. is considering the purchase of ABC Co. Marko believes that ABC Co. can generate cash flows of $5,000, $9,000, and $15,000 over the next three years, respectively. After that time, they feel the business will be worthless. Marko has determined that a 14 percent rate of return is applicable to this potential purchase. What is Marko willing to pay today to buy ABC Co.?
a. $19,201.76
b. $21,435.74
c. $23,457.96
d. $27,808.17
e. $31,758.00
26.You would like to establish a trust fund that will provide $50,000 a year forever for your heirs. The trust fund is going to be invested very conservatively so the expected rate of return is only 2.75 percent. How much money must you deposit today to fund this gift for your heirs?
a. $1,333,333.33
b. $1,375,000.00
c. $1,425,000.00
d. $1,666,666.67
e. $1,818,181.82
27.In the event of default, debt holders are considered to have a more _____ claim on the firm than common stockholders, and common stockholders have a more _____ claim than preferred stockholders.
a. short-term; long-term
b. long-term; short-term
c. senior; junior
d. junior; senior
e. senior; senior
28.A bond with a 7 percent coupon that pays interest semi-annually and is priced at a premium could have a market price of _____ and will have interest payments in the amount of _____ each.
a. $934.58; $70
b. $1,070; $35
c. $1,070; $70
d. $934.58; $35
e. $1,000; $70
29.A General Co. bond has an 8 percent coupon and pays interest annually. The face value is $1,000 and the current market price is $1,020.50. The bond matures in 20 years. What is the yield to maturity?
a. 7.79 percent
b. 7.82 percent
c. 8.00 percent
d. 8.04 percent
e. 8.12 percent
30.Party Time, Inc. has a 6 percent coupon bond that matures in 11 years. The bond pays interest semiannually. What is the market price of a $1,000 face value bond if the yield to maturity is 12.9 percent?
a. $434.59
b. $580.86
c. $600.34
d. $605.92
e. $947.87
31. The dividend growth model:
I. assumes that dividends increase at a constant rate forever.
II. can be used to compute a stock price at any point of time.
III. states that the market price of a stock is only affected by the amount of the dividend.
IV. considers capital gains but ignores the dividend yield.
a. I only
b. II only
c. III and IV only
d. I and II only
e. I, II, and III only
32. Michaels, Inc. just paid $1.40 to their shareholders as the annual dividend. Simultaneously, the company announced that future dividends will be increasing by 4.5 percent. If you require an 8 percent rate of return, how much are you willing to pay to purchase one share of Michaels stock?
a. $31.11
b. $32.51
c. $40.00
d. $41.80
e. $43.68
33. Majestic Homes stock traditionally provides an 8 percent rate of return (EAR). The company
just paid a $2 dividend which is expected to increase by 1.5 percent per quarter. If
you are planning on buying 1,000 shares of this stock next year, how much should you
expect to pay per share if the market rate of return for this type of security is 9 percent (EAR)
at the time of your purchase?
a. $451.82
b. $26.67
c. $400.00
d. $295.06
e. $266.67
34.The common stock of Grady Co. returned an 11.25 percent rate of return last year. The dividend amount was $.70 a share which equated to a dividend yield of 1.5 percent. What was the capital gains yield on the stock?
a. 1.50 percent
b. 8.00 percent
c. 9.75 percent
d. 11.25 percent
e. 12.75 percent
35. The Extreme Reaches Corp. last paid a $1.50 per share annual dividend. The company is planning on paying $3.00, and $5.00 a share over the next two years, respectively. After that the dividend will be a constant $2.50 per share per year. What is the market price of this stock if the market rate of return is 15 percent?
a. $17.04
b. $18.99
c. $26.57
d. $29.08
e. $33.71
Short Answer (1.5 points each)
1. What is the goal of the firm?
2. What is price (of a financial asset)?
Computational Problem (Each part 3 points) BE SURE TO SHOW ALL WORK!!! (Calculator entries or formulas). Answer in complete sentences!
Batman decides he wants to help Robin save for retirement. Robin is currently 30 years old and wants to retire at age 62. He expects to live for 20 years after he retires. Batman plans to invest $25,000 at the end of each year into a retirement account that earns an APR of 9%, compounded monthly.
a. What is the appropriate discount rate.
b. Assume an answer of 10% to part (a). How much will Robin have in his account at the time of his retirement?
c. Assume an answer of 10% to part (a) and 5,000,000 to part (b). Robin wants to withdraw funds monthly once he retires so that he will have no money left in the account after 20 years. What is the appropriate discount rate? How much can he withdraw per month?
d. Alternatively, Superman is considering acquiring a new sidekick and knows Robin feels underappreciated in his current employ. He has offered to fund a retirement account for Robin with $350,000 today at an APR of 8% compounded annually. If Robin chooses Batmans option, what does foregoing this alternative represent? Why did Robin choose Batmans option (what is Supermans option worth at his retirement)?